M&A analysis (Accretion / Dilution) when target tech startup has negative FCF?
Hi All,
How should we go about M&A analysis (Accretion / Dilution) when the target tech startup has negative FCFF? EPS will decrease, so how to justify the txn quantitatively?
I believe it would be a standard question for people in Tech, as many highly valued targets have negative FCFF.
Appreciate the help!
It'd be very difficult to justify it quantitatively so you'd need to build a LT story about how the investment would be worth it (maybe showing market growth or potential future synergies).
If it’s an all equity transaction you could see if revenue per share is accretive but it’s a dodgy and pretty useless metric.
Correct me if I'm wrong but unless you have synergies you will never have accretion if a company has negative FCF in this case.
You're right, no earnings accretion in the traditional sense. As far as I know, for loss making companies with revenues and an all equity transaction, you can see if the combined revenues per share improve or not.
Wtf does revenue accretion/dilution even mean
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Usually you would extend your explicit forecast period to 10 years or so and see the target's FCF turn positive to justify the deal
I would agree this is the best approach for this, if you really wanted a model justificatoon for the deal.
The point of acquiring high growth tech companies is in its name - growth. You're not purchasing it to obtain immediate EPS / value accretion; you buy it knowing that it will potentially generate masses of earnings and cash flows in the future. A standard 1, 2 or even 5 year accretion will not showcase this benefit.
(1) Even if FCF was positive, it makes little sense to run accretion / dilution in an acquisition of a start-up (size too small) unless its growing at triple digits
There must have been some rationale why this start-up is acquired - use that as a starting point. With this start-up under your client’s umbrella, will you be able to grow certain product line perhaps?
(2) It all boils down to how much info you have.
(3) A bit puzzled how a start-up managed to get listed. Is it really a start up?
Surprised no one brought this up yet. If FCF is negative because of massive capex or NWC shortfalls while income statement items aren't negative, you can still have an accretive deal. That said, if capex is super high and the co is in growth mode, I'd bet operating results aren't that great either. But just saying "negative FCF" doesn't mean the numbers won't be accretive without further info. Especially if it's all-cash and therefore no share count dilution
I don't think that would apply here - its a tech company, which is not typically high in capex. The likely cause of the negative FCF is due to negative earnings (high expenses, little revenue), not due to cash flow items
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